Due Diligence and the Thud Factor
The new world order of banking has brought about significant changes to the amount of information businesses have to provide banks in order to obtain credit.
No longer is a handshake with your bank loan officer enough to qualify for a business loan. Many banks are still not making business loans at all. The ones that are have become very cautious of making a good credit decision. But that isn’t enough. They are also very cautious about what the banking regulators are going to think about their loan decision. Bankers that are loaning to businesses today are trying to protect themselves from second guessing regulators.
Banks are generally examined by several banking regulatory agencies on a regular basis. If a bank is a nationally chartered bank, it will be examined annually by the Office of Comptroller of Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC). The primary examination the OCC conducts is a safety and soundness exam. A safety and soundness exam looks at the whole bank operation but mostly loans and loan loss exposures. They may also examine other aspects of a bank like IT security and compliance with the massive numbers of banking regulations. The FDIC examines all federally insured banks for loan losses. The FDIC insurance is what pays deposit holders if a bank fails.
If a bank is a state chartered bank then they typically will have their state banking regulators come in and do a safety and soundness examination and the FDIC will look at loan loss exposure. To the best of my knowledge, there are not many banks that aren’t insured by the FDIC.
Given the climate on Capitol Hill right now, banks that are doing things right are still very nervous. Many bankers are nervous about the proposals of having a federal “super-regulator” that would have much more power than the multiple federal banking regulators have now individually. The uncertainty that even the most business-friendly bankers are feeling is pretty scary.
In the past several months, my company, which helps small businesses secure debt from banks and other lenders, has seen a trend: Business friendly banks are doing massive amounts of due diligence on loan requests. These banks haven’t had as much of a problem making a credit decision. Rather, they are worrying about how to document their loans so they can be prepared for any question or criticism that may come up when a regulator looks at the loan file.
I have come to call this phenomenon the “Thud” factor. My theory is the heavier the loan file is and the louder the “thud” produced when the file hits the ground, the less likely the bank will get criticized by regulators.
Many borrowers are concerned when they see the list of documents, financial statements, projections, appraisals, and collateral lists that banks want to see. Well friends, the list has recently gotten much longer. Recently, after presenting a loan to a bank and the bank giving their thumbs up, the lenders came up with their list of additional supporting documents they needed to show regulators. The extra work for the borrower is annoying but at least the loans are being made.
In order to avoid delays in loan approval and to help prepare a loan for your bank to approve and fund it quickly, I have a few recommendations:
- Keep the most accurate financial records you can.
- Make sure you have an interim financial statement dated within the last 90 days. If the last quarterly financial statement is older than 90 days before the loan closes, expect to update it.
- Keep all your corporate organizational records, minutes, bylaws and all other corporate documents well organized and in a safe place.
- Make sure you can easily show proof of IRS 941 trust tax payments and reports for at least the last four quarters.
- Expect any conventional business loan made today to require “key man” life insurance.
- If you have multiple shareholders make sure and keep an accurate and up-to-date capitalization table and stock transfer ledger.
- Make sure key management biographies are up to date.
- At least once a year have every 20% or greater owner request their personal credit report from all three major credit agencies that report personal credit. Correct any discrepancies.
- Keep up to date personal financial statements for every 20% or greater shareholder. Make sure they are 100% accurate. Don’t guess on liabilities.
- Make sure all information matches across documents. If John Doe is named the CEO in one document, make sure he isn’t named the President in another. Those little details are what bankers are afraid the regulators are looking for.
- Prepare a two-page summary that explains your business model and source of revenues. Make sure it is understandable.
Take as much time as necessary putting together your loan package and make sure all information is accurate. Expect that once you have submitted your loan application your banker will come back with one or two more lists of questions. Your written answers to questions will help your banker build a “regulator proof” loan file.
Most importantly, don’t take all the requests for information personally. It is just a part of lending in 2010.
Sam Thacker is a partner in Austin Texas based Business Finance Solutions.
You may contact Sam directly at: sam@lesliethacker.com
or follow him on Twitter: SMBfinance
EXTRA: If you have questions for Sam regarding business financing, the credit market, and similar issues, please send an e-mail. Your questions will be recorded and Sam will answer the best ones in his podcast show.
